Why the ABS Data Warehouse Must be Free of Conflicts of Interest

It is common sense that there are no benefits to be gained from tilting an otherwise level playing field by letting firms with conflicts of interest participate in selecting, designing, constructing or operating the ABS Data Warehouse.

All firms involved with the ABS data warehouse should be verifiably free of conflicts of interest with existing structured finance market participants.  These firms should make and keep updated a full public disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

• Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.

• Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?

If the ABS Data Warehouse is to be valuable in restoring trust in the structured finance market, the data must be trusted.  Unfortunately, there are many ways that conflicts of interest might raise doubts about the trustworthiness of the data.

Recently, the European Commission announced an investigation of Markit which shows how conflicts of interest jeopardize the trustworthiness of the information and can lead to potential problems.

Markit is the leading vendor of information on credit default swaps.  It also happens to have a majority of its shares owned by 16 major dealers of credit default swaps.  Because of their ownership interest, these dealers have an incentive to only supply Markit with information.  In addition, since they control Markit, they are in a position to control what data is disclosed and when it is disclosed.  Taken together, all of the conflicts of interest that exist within Markit have drawn the European Commission's attention and call into question the trustworthiness of the data Markit provides.

40 firms would like to build ABS Data Warehouse, only my firm has

An IFR article provided an in-depth look at the ABS Data Warehouse.

More than 40 organisations have expressed an interest in building the European Central Bank-endorsed, market-led ABS loan level data warehouse, according to officials at the Market Group overseeing the project.

Of the 40 organizations, only your humble blogger's firm has actually built and patented an ABS loan-level data warehouse and the information infrastructure to support it.

While the general consensus among market participants is that the creation of a centralised ABS data warehouse will restore confidence in the European structured finance markets by ensuring investor access to comprehensive, standardised and timely information, there are growing concerns that the endorsement from the ECB will create an uneven playing field.

As discussed in an earlier post, unless the ABS data warehouse offers current loan-level performance information it will not restore confidence.  Offering loan-level performance data on a once per month basis would just be a continuation of the status quo that failed disastrously leading up the credit crisis.

Other sources, meanwhile, have said that the process is 'hopelessly complicated' and that the Market Group could have made the plan more straightforward.

Actually, as discussed in an earlier post, the process for selecting BlackRock is very straightforward.

What makes the selection process appear complicated is the lengthy request for information that is irrelevant to answering the questions "do you have proven domain expertise in designing an ABS data warehouse and its related information infrastructure" and "what conflicts of interest do you have in the design, construction and ongoing operation of the ABS data warehouse?"

The information requested is highly relevant to answering the question "are you BlackRock?"

A formal Request for Information was sent out last Friday to the interested parties - including specialist data providers, exchanges and IT firms from Europe and the US - and is open for 10 days, after which the Market Group will shortlist suitable candidates for the Request for Proposal stage.

Following the construction of the data warehouse, a private placement of shares in the warehouse is expected to take place, anticipated to be similar to the formation of Euroclear, with the constructor of the warehouse limited to 15 pct of the shares.

It is understandable why BlackRock, with its overwhelmingly large number of conflicts of interest, should be restricted to 15 percent ownership of the data warehouse.

But why should there be any limit on the ownership of the data warehouse by a constructor with no conflicts of interest?  In fact, why should that constructor not own 100% of the data warehouse?

Royal Bank of Scotland analyst Ganesh Rajendra expressed concern that a central bank-endorsed initiative, under which the cost of available collateral data would be passed through to end-users, was creating a market monopoly through a 'utility-like' pricing service. 

This approach is in contrast to the US Securities & Exchange Commission and the Bank of England's data reporting requirements, where issuers absorb the cost of compliance and make their collateral data publicly and freely available to the market. 

'How that data is aggregated and distributed is then usually left to the market,' said Rajendra. 

'The ECB's spearheading role in this regard still confounds us, considering the many private sector data vendors that exist and compete in the European securitisation credit market today.' 

Rajendra, stop confusing the issue with the facts.  You are missing the large number of firms which are investors in Markit and have been able to make a substantial return on their investment.  Everyone sitting on the ECB's technical working group would like to repeat this with the ABS data warehouse.

It is a minor inconvenience that last week the European Commission announced its investigation of Markit and expressed its strong concern over potential conflicts of interest when it comes to financial data providers with a monopoly.

However, supporters of the initiative argue that third-party data providers will still be able to analyse and model the raw data available in the warehouse for the investors that require it. 

This response does not mean that the ABS data warehouse is not a monopolist.  With the ECB endorsement, it will be.

At best, this response suggests that the ABS data warehouse's business model will stop with providing a snapshot of the performance of the structured finance security at one point in time and it will leave value added analysis to others.

In addition, originators will maintain the ability to circulate their data to anyone that requests it. 

'The data warehouse is not an exclusive or closed user group but is an open platform that seeks to promote data consistency and transparency in the ABS market,' said Paul Burdell, CEO at Link Financial, a receivables management company and one of the members of the RMBS technical working group for the initiative.

Hello!  What European originator is going to provide their data somewhere else given that the ECB looks to the ABS data warehouse for information on securities that are eligible to be pledged to the ECB?

The price of access to the warehouse's information will be key to the initiative's success, according to Gareth Davies, head of ABS research at JP Morgan, also one of the members of the RMBS technical working group for the initiative. 

He acknowledged the concerns related to the cost of information, noting that a pricing committee will be established, made up of a representative sub-group of the investing community in the warehouse initiative. Clearly, the more participants involved in the private placement, the more successful the pricing process will be.

'On the assumption that these investors will have an eye to making this initiative successful to ensure a return on their initial investment, we would expect pricing power to be relatively constrained by market forces,' he said. 'If not priced correctly, the initiative will fail.' 

Actually, any committee of investors who are not also shareholders of the ABS data warehouse will set the price for accessing the data at zero.

If there is any doubt about this price level, the Association of Mortgage Investors eliminated it in March 2010 when it expressed its opinion about being made to pay for loan-level data [emphasis added]

The fact that investors have to pay to subscribe to services such as Loan Performance to get data on collateral underlying asset-backed securities they are offered and may already hold is outrageous in light of the no-cost extensive public disclosure required for corporate securities.

The initiative does not have to fail if investors and other market participants are unwilling to pay for the data.  Instead, as pointed out by Rajendra, the issuers could pay.

I realize that issuers paying by building the cost of the ABS data warehouse into each deal would prevent the issuers from having their cake (all costs pushed onto investors) and eating it too (make a substantial capital gain from the investors having to spend money to access data they should get for free).

... The ECB has released its loan-by-loan information requirements for CMBS and SME transactions, which will be introduced for transactions accepted in the Eurosystem collateral framework within the next 18 months. 

This follows the release of requirements for RMBS at the end of last year. All three templates have mandatory and non-mandatory fields and will operate under a 'comply or explain' principle: thus if a counterparty is unable to complete a mandatory field, the transaction may still be eligible, provided that a satisfactory rationale is given. 

'While there is a risk certain smaller non-securitisation dependent lenders will simply opt not to use securitisation as a funding tool, generally the regulations should lead to further commoditisation of data provision and ultimately result in overall improved transparency,' said Conor O'Toole, analyst at Deutsche Bank. 

ABS is now the most common collateral group posted at the ECB's repo window for the first time, according to the central bank's 2010 annual report. ABS represented 24 pct of total collateral, up from 23 pct in 2009, followed by covered bonds at 21 pct. 

This is significant, particularly given that the ECB has made eligibility criteria for repo transactions far more stringent over the past year, such as tougher rating haircuts.

This is the explanation for why the ECB is pushing so hard to get the ABS data warehouse built.

Free, Current Data or Costly, Stale Data from ABS Data Warehouse

Under the FDR Framework, regulators, like the ECB and BoE, are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner.

But what is meant by the term "all market participants have access"?  This term can be broken into two parts.

• "All market participants" means everyone.  This includes, but is not limited to, investors ranging from mom or pop to PIMCO or BlackRock, rating services, pricing services, data vendors and regulators.

• "Have access" means there are no barriers, like the need to pay for the data, between the market participants and the disclosed information.

Historically, for structured finance securities there have been access barriers.   Market participants can access reports for free at the issuer's or trustee's web site or pay a fee to access the loan-level performance data through a data vendor.

In March 2010, the Association of Mortgage Investors expressed its opinion about being made to pay for loan-level data [emphasis added]

The fact that investors have to pay to subscribe to services such as Loan Performance to get data on collateral underlying asset-backed securities they are offered and may already hold is outrageous in light of the no-cost extensive public disclosure required for corporate securities.

Apparently, investors prefer to access loan-level performance data for free.

But not so the ECB.  In its letter supporting the creation of the ABS Data Warehouse,

Once constructed (... reflected in the fees levied on the users of the Data Warehouse...) the Eurosystem intends to make use of the Data Warehouse in connection with the Eurosystem collateral information requirements approved by the Governing Council in December 2010.

Apparently, the ECB does not mind having to pay to access loan-level performance data.

Unfortunately, the ECB's willingness to pay for data outweighed the investors' preferences for not paying for data when it came to selecting the business model of the ABS Data Warehouse.  As the quote from the letter supporting the creation of the ABS Data Warehouse shows, the ECB supports a business model based on charging market participants for accessing the data.

There is an alternative model that was described in your humble blogger's response to the ECB's Public Consultation.  The alternative model is to build the cost of the data warehouse into the cash flow for each deal.  Under this model, which is preferred by investors, all market participants can access the loan-level performance data for free.

In a previous post, we discussed how the ECB and BoE preferred the status quo of market participants receiving old, stale data on a once per month basis.  This preference can be combined with the ECB's preference for charging for accessing this data.  Taken together, the implied preference of the ECB [and also the BoE given its support of the ECB's activities] is to have market participants pay for old, stale data.

By comparison, your humble blogger prefers, since Wall Street through its servicing subsidiaries has access to current loan-level performance data, to have all market participants have access to current loan-level performance data.  This preference can also be combined with the investors' preference for offering access to this data for free.  Taken together, the preference of investors and your humble blogger is to have market participants have access to current loan-level performance information for free.

Which seems more likely to help the ABS Data Warehouse achieve its mission of

Facilita[ting] investment and support[ing] transparency, integrity and restor[ing] confidence in the structured finance markets

free, current loan-level performance information or costly, stale once per month loan-level performance information?  Common sense suggests that the answer is free, current loan-level performance information.

Your humble blogger is looking forward to helping the ECB and BoE construct and operate the ABS Data Warehouse using my patented solution and provide free, current loan-level performance information on structured finance and covered bond securities to all market participants.

Will the ECB's ABS Data Warehouse Restore Investor Confidence? No!

Last year, the ECB and the BoE set out to address the issue of the frozen structured finance market and its opaque, toxic securities.  Specifically, they set out to remove opacity.

As regular readers of this blog know, under the FDR Framework, regulators are responsible for ensuring that all market participants have access to all the useful, relevant information in an appropriate, timely manner.  So the ECB and BoE focus on removing opacity properly reflects this responsibility.

Common sense says that if the goal is to remove opacity, then the starting point is to know what elements of structured finance securities contribute to making them opaque.  Without doing this analysis, how could the ECB or BoE know if they had removed opacity?

Each specific aspect of the regulators' responsibility can be linked to an element of the structured finance security.  For example, regulators could look at when information is disclosed and match this to the issue of timely disclosure.

The result of this simple analysis is a matrix.  Across the top in the columns are the issues the regulators are responsible for under the FDR Framework.  Down the lefthand side in the rows are the different types of structured finance securities.

Included in the rows are subprime mortgage backed securities.  These securities are synonymous with opaque, toxic securities.

Had the regulators looked at when loan-level performance information was disclosed for subprime mortgage backed securities, they would have found that it was done on a once per month basis.  Did this once per month disclosure of loan-level performance data contribute to the hundreds of billions of dollars of losses on subprime mortgage backed securities?

The European Commission and the European Parliament certainly thought so.  In May 2009, the European Parliament passed Article 122a which amended the European Capital Requirements Directive and required that financial institutions [broadly defined] know what they own when buying structured finance securities.  This was an explicit rejection of the adequacy of once per month disclosure.

Wall Street certainly thought that once per month disclosure of loan-level performance data contributed to the losses.  According to a Reuter's article on Goldman Sachs and Litton Loan Servicing

Goldman bought Litton in 2007 [it had an investment made years earlier in Senderra, another subprime originator and servicer] for about $430 million.  At the time, many banks looked at buying servicing arms to gain useful information about home loan performance for their mortgage bond trading businesses.

What useful information about home loan performance would a servicing company have?  It would have current information on how each loan was performing.  By comparison, the investors in the subprime securities would receive out of date loan-level performance data in the once per month disclosure.

The fact that banks purchased servicing companies for current loan-level performance information confirms the fact that they were aware that they were buying tomorrow's news today and using it to trade against investors.

Common sense says that restoring investor confidence requires providing investors with current information on how each loan is performing too. 

Your humble blogger submitted responses which highlighted Wall Street's answer to the ECB's and BoE's respective Public Consultations (see here and here).  To drive home the point, the responses used a brown paper bag to illustrate the opacity of once per month loan-level disclosure and a clear plastic bag to illustrate the transparency of current loan-level disclosure.  There is universal agreement that it is easier to analyze and value the contents of a transparent, clear plastic bag than the unknown contents of an opaque, brown paper bag.

However, to be fair, the ECB and BoE also would have had other responses to their Public Consultations. If the composition of the respondents to the ECB and BoE Public Consultations were similar to what the Committee of European Bank Supervisors received on its related Public Consultation, my response would have been the only one in favor of providing current information.  The rest, since they came from representatives of the sell-side would have preferred the status quo.

Presumably, the responses from the sell-side were ignored or at least highly discounted.  After all, the ECB and the BoE knew from the January 2009 Group of Thirty report (co-authored by Jean-Claude Trichet and Mervyn King) that when it came to reforming structured finance, they were suppose to listen to the responses from everyone other than the sell-side firms, law firms representing the sell-side and lobbying organizations like AFME that are controlled by the sell-side.

So what did the ECB and BoE decide with regards to once per month loan-level performance disclosure?

The ECB and BoE decided that the opacity of once per month loan-level performance disclosure was adequate transparency for market participants, including themselves, to evaluate the risk of and price structured finance securities.  

Let me repeat that.  The ECB and the BoE decided that for restoring investor confidence in the structured finance market and managing the risk of structured finance securities on the ECB's and BoE's balance sheet it was preferable to be valuing the unknown contents of a brown paper bag than valuing the known contents of a clear plastic bag.

In doing so, they revealed a preference for stale, out of date information over fresh, current information.  They also revealed a preference for maintaining the status quo and allowing Wall Street to trade with the informational advantage of having tomorrow's news today.

Given that the ECB's ABS Data Warehouse embraces once per month disclosure, why should it succeed in restoring investor confidence in structured finance?

Investors are smart enough to know and have experience that shows if Wall Street has an informational advantage, Wall Street will use this informational advantage to the detriment of the investors.  Other than blindly chasing yields because central bankers keep rates low, what would ever cause an investor to purchase a structured finance security given that Wall Street knows what they are buying and the investor does not?

ECB ABS Data Warehouse: So much for ensuring independent, fair, open and market-driven selection process

What do you think the ECB meant when it wrote

The Eurosystem is fully committed to ensuring an independent, fair, open and market-driven selection process in relation to the warehouse constructor and oversight of the Data Warehouse.

Sounds like the Eurosystem intended that every aspect of the selection process should be made available to all structured finance market participants by being fully disclosed over the Internet.  This of course would include issues like public disclosure of conflicts of interest and showing actual proven domain expertise in designing the supporting information system and the data warehouse.

If this is what the Eurosystem intended, why has the Eurosystem not publicly distanced itself from the Market Group?

The Market Group's selection process is the very definition of hiding under the cloak of opacity.

• Its members' names are only available on a confidential basis.  [Hiding the names of the members does not mean eliminating the European Commission concern over how the member's conflicts of interest influence the selection process, design, development and operation of the data warehouse.]

• Exactly what they would like built and therefore the criteria that it will use to select the warehouse constructor and oversight of the data warehouse is secret.

This does not look like an independent, fair, open and market-driven selection process.  It looks like a beauty contest being conducted behind closed doors where the winner, most likely BlackRock [which sits on the ABS technical working group advising the ECB], has already been predetermined.

But a result like this is not unexpected given that the Eurosystem is acting in a way that shows it is completely insensitive to the European Commission's concerns regarding financial information monopolies and conflicts of interest.

How the ECB's ABS Data Warehouse can Avoid European Commission's Concern

As discussed in a previous post, the ABS Data Warehouse is likely to become the global structured finance market's 'go-to' source for ABS loan-level data.  It will effectively become a global monopoly due to the ECB's endorsement.

This will put the ABS Data Warehouse directly in the crosshairs of the European Commission.  According to an article in the Wall Street Journal,

[T]he [European] Commission spokeswoman said, "the Commission does not look into all agreements and at the behavior of all companies; only those that may contain practices that are restrictive of competition and at companies that may have a dominant position and be abusing it."

Knowing that the ABS Data Warehouse will be in the European Commission's crosshairs, before it is even created, the European Central Bank should take steps to ensure that it is free from any potential conflicts of interest that might attract the European Commission's attention.

This is actually quite simple for the ECB to do.


The ECB has to require that any firm involved in selecting, designing, constructing or operating the ABS Data Warehouse be verifiably free of conflicts of interest with existing structured finance market participants.  


Enforcing this requirement involves two steps.


First, having any firm that would like to be involved in selecting, designing, constructing or operating the ABS Data Warehouse make a full public disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

• Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.

• Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?

Second, excluding those firms with related business or investments that could gain an advantage from any involvement in the selection, design, construction or operation of the ABS Data Warehouse.


There are no benefits to be gained from tilting an otherwise level playing field by letting firms with conflicts of interest participate in the ABS Data Warehouse.

ECB 'Groundbreaking ABS Data Warehouse' Was My Idea

On April 14, 2008, Total Securitization ran a Learning Curve column that set forth the ABS Data Warehouse in unambiguous detail.  This column laid out why the data warehouse (referred to in the column as the master database) is needed, how the database should be paid for, and the need for the owner(s)/operator(s) of the data warehouse to avoid all conflicts of interest with existing structured finance market participants.

Please note the date.  The column ran over two years prior to the ECB's Public Consultation on providing loan-level data on ABS securities and the groundbreaking ABS Data Warehouse.  The column ran over three years before the European Commission began to investigate the conflicts of interest involving Markit, its investors and the credit default swap market.

Here is the column as written by your humble blogger.

       Transparency is rapidly emerging as the solution for restoring trust in pricing and therefore liquidity in the structured finance markets.  It is the cure for several ills caused by opacity in the existing deals which has frozen worldwide capital markets.  Without it, market participants face an epidemic of worry about potential losses and a loss of confidence in the firms they do business with.  Without it, the actual performance of the collateral backing each deal must be guessed when valuing and rating each security.  Without it, sellers don’t know what price to ask for and buyers don’t know what price to pay.  With it, market participants can do fundamental data analysis on each structured finance deal and all of the securities that were issued as part of the deal.  With it, all relevant knowable facts can be used to value and rate each security.  With it, risk can be managed.

What Exactly Is Transparency?

It is the data on the underlying collateral performance presented in such a way that market participants can easily understand what is going on despite the complexity of each structured finance transaction.  It is this data former Federal Reserve Chairman Paul Volker asked about when he commented on the Fed taking over the mortgage and mortgage-backed securities of questionable pedigree from Bear Stearns and wondered how this collateral was “good collateral tested to the point of no return.''  It is this data and the access to this data that, when combined with TRACE, Regulators have focused on in the Presidential Working Group recommendations to restore liquidity in the secondary market.

            The gold standard for transparency is easily accessible and usable real time, standardized loan-level detail on the underlying collateral over the life of each structured finance deal.  On an ongoing basis, the gold standard brings the loan-by-loan data that is available in the primary issuance market into the secondary market. 

Under this standard, collateral performance data is made available at each end user’s desktop so they can use it in the analytic and pricing models of their choice.  This data reflects everything that has happened through the close of business yesterday.  Data from the close of business yesterday has two advantages.  First, it is what was recorded in the audited financials.  Second, it avoids settlement cycle issues where payments received by check in the morning might be backed out for insufficient funds in the afternoon. 

The data is standardized to maximize its usability.  This allows for comparisons across both a single Issuer’s deals and across multiple Issuers’ deals for the same asset type.  It also allows securities which involve multiple different Issuers and assets types like CDOs, CDO²  and, because their performance is driven by the cash market, synthetic CDOs to be analyzed and compared.  Finally, each deal can be monitored and therefore the investment risk managed over the life of the deal.

Transparency's Value to Issuers

            By offering transparency, Issuers can save themselves the cost of opacity.  This cost or opacity premium equals the increase, since the credit crisis began, in the risk and liquidity premiums in the primary issuance market. The increased risk premium reflects the perception of a higher probability that the underlying collateral will not perform as expected.  The increased liquidity premium reflects that, without transparency, Investors are going to have to hold the asset for the life of the deal because other Investors don’t know what is backing the deal and therefore are unlikely to buy it.  For those Issuers who can’t tap the capital markets on acceptable terms, the cost of opacity is the ability to access the capital markets.  The cost of opacity was calculated from Deutsche Bank’s March 2008 Securitization Monthly and is presented below.

Asset Type	Annual Cost (in $mln per $1B Issued)
U.S. Government Insured Student Loans	$5.0
Credit Card Receivables	$6.5
Auto Loans	$11.1
Agency Home Mortgages	$11.4
Commercial Mortgages	$19.0

This cost reduces the Issuer’s income each year the deal is outstanding.

The Rating Services, particularly Moody’s, are indicating that providing transparency will also factor into the deal rating.  They are looking for standardized loan level detail over the life of each deal and will favor greater transparency.

To reduce the cost of opacity and improve the ratings on their deals, Issuers are looking for the best transparency solution.  The key characteristics of this solution include that it minimizes the cost and burden on the Issuer of providing transparency, it is administered by a third party to insure data integrity, and it maximizes the effectiveness of the transparency being provided by making the data available to all market participants.

How Transparency Will Be Offered?

            While the actual mechanics of providing transparency are very complex, the basic framework is easily described.  The collateral performance data will be collected in a master database from every Issuer for every deal whether or not the deal was publicly issued or privately placed.  The master database is needed so that CDOs and other securities like CDO² can be analyzed, valued and monitored.  The master database is a transaction portal which insures improved data availability to all structured finance market participants.  This data will be made available to End Users either directly or through Data Distributors.  Potential Data Distributors include, among others, firms like Bloomberg, Intex and LoanPerformance.  Along with the actual performance data, these Data Distributors may provide analytic and/or pricing models.  Each End User will be able to get the data that they want.  For example, Rating Services might want every field in the data set monthly while Investors might want fewer fields in the data set daily.  In addition, because U.S. firms need to comply with Sarbanes-Oxley, the data will be made available to all market participants at the same time each day.  Finally, the Issuers will be able to control who has access to information on privately placed deals.  By limiting access, the Issuers can maintain the confidentiality of their proprietary deal structures.

            Based on its sheer size, the master database is likely to be physically maintained by several large firms that currently provide financial data services to the structured finance industry.  Overall coordination of the master database should be by a company whose sole business is overseeing the collection of the data from the Issuers’ accounting systems, the verification and validation of this data, the standardization of this data, the linking of the data to specific deals, the production of summary reports and the dissemination of the information to Data Distributors and End Users.  The role of this company is critical because it bridges the gap between the Issuers and the Data Distributors and End Users.  It is the company that works with Data Distributors and End Users to be sure that they get the data that they need.  This lowers the industry’s cost of providing transparency to each End User’s desktop while maintaining the highest possible quality standards for the data.  This also maximizes the flexibility of the transparency transmission mechanism so that it can meet the evolving needs for transparency into the future. 

          Ultimately, the transparency data is useless if market participants don’t trust it.  By definition, the company coordinating the master database must be free of the types of structural conflicts of interest that would be present if the company were a Data Distributor, an analytic and pricing model vendor, Rating Service, Bond Insurer, Trustee or Investor. The company’s business model must stop with the snapshot that answers the questions of what is the actual collateral performance to date and what does this performance mean for the structured finance deal.  

The spread of Transparency

            For the structured finance industry to move forward and grow, transparency must be offered on a global basis. Transparency must take into account differences in regulation.  For example, in Europe there are laws protecting borrower privacy.  In the U.S., similar privacy laws exist for patient privacy and healthcare receivables transactions have had to comply with this law.  By applying the HIPAA standard for patient privacy to U.S. borrowers, the transparency solution also complies with the European privacy laws.

Conclusion

            The need for and implementation of the transparency gold standard is the major task facing the structured finance market today.  As noted above, every participant in the industry, including Regulators, Issuers, Rating Services and Investors, is demanding transparency.  This is a major step forward.  Now we need industry leaders to implement the solution and help end the paralysis in the capital markets.  By providing real-time, standardized loan level data to market participants, the fear of owning or buying the unknown is eliminated and the structured finance market can function properly again.

ECB paves the way for loan-level utility

In a recent International Asset-Backed Strategy report, an RBS analyst discusses the ECB and the ABS Data Warehouse it is seeking to create.

This report reaffirms why the ABS Data Warehouse with its monopoly on loan-level information has to be free of conflicts of interest with existing structured finance market participants.

Following its decision to enforce loan-by-loan level reporting requirements on the European securitisation market as announced in December 2010, last week the ECB announced its intent to utilise a central data repository for these purposes, with provisional plans for this “Data Warehouse” to process, verify and ultimately distribute standardised ABS loan level data to market users. 

The ECB’s Eurosystem will be one such user, verifying the info against its loan-level requirements (see below for detail) in order for ABS assets to be repo-eligible, although the statement makes the point that its subscriber role in this respect is intended to be non-exclusive. 

The ECB’s letter of intent published last week cites that an independent, external party will be charged with building the ABS data warehouse, selected following an open tender process. 

The concept of a central bank taking the lead in such an initiative is certainly novel, if not alien to us, indeed the norm (at least in the case of the US SEC and Bank of England’s data reporting requirements) is for securitisation issuers to absorb the cost of compliance and make their collateral data publicly and freely available, subject to regulator’s loan fields criteria. How that data is aggregated and distributed is then usually left to the market. 

Our read of the ECB’s letter of intent is that the central bank aims to be a “catalyst” to what it hopes will be a market-led initiative to create a central ABS data warehouse (and this has indeed happened – see below), yet the ECB’s spearheading role in this regard still confounds us considering the many private sector data vendors that exist and compete in the European securitisation credit market today.  

In any case, we would see an ECB-endorsed (even if “non-exclusive”) data provider as an effective market monopoly in the ABS data aggregation business, presumably leaving current vendors to compete on higher value-add analytics following its creation. 

I agree that the ECB-endorsement makes the ABS Data Warehouse an effective monopoly first in Europe and subsequently globally.

The ECB’s letter of intent states that “To the extent possible, market participants will have the opportunity to use and invest in the Data Warehouse subject to entering into appropriate legal arrangements” – while this statement appears to encourage a ‘market-owned’ data provider, we think the difficult practicalities of creating such a socialised venture will mean that the project likely ends up going to a private firm(s). 

This was in fact directly indicated by a press release issued on April 28th from a group of market participants (originators and investors) stating that they will oversee and manage the selection process for the construction and administration of the Data Warehouse, which according to the press release will allow ABS issuers to submit loan-level data electronically, which will then be verified and audited for compliance with the ECB’s criteria requirements for repo eligibility. (The invitation to tender kicks off on 6th May according to the group’s press release). 

It is precisely because the ECB-endorsement effectively makes the ABS Data Warehouse a monopoly that there is no doubt that the European Commission's concerns over conflicts of interest with Markit would apply to any investor in the ABS Data Warehouse.  This would also be true of any party, like the Market Group, that could influence the day-to-day operation of the ABS Data Warehouse through activities like selecting the constructor of the ABS Data Warehouse.

The ECB’s letter of intent suggests that technical specifications and other performance obligations will form part of the tender process and requirements of the data administrator, and that the scope of the tender is intended to ensure competitive pricing that will be ultimately passed through to end-users via a fee-based data information service. 

As mentioned in an earlier blog, the ECB should instead specify two criteria.

First, that the firm that constructs and operates the ABS Data Warehouse be verifiably free of conflicts of interest with existing structured finance market participants.  This requires that any firm that is involved in either the day-to-day operation of the ABS Data Warehouse or the Coordinator role should be required to make a full disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

• Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.

• Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?

Second, that the firm that constructs and operates the ABS Data Warehouse have demonstrated domain expertise in designing the necessary information system for collecting, verifying, standardizing and disseminating loan-level data for structure finance securities.

To us at least, it would appear that – unlike the private vendor market currently – the ECB is looking to create an almost regulated or utility-like pricing service that is accessible to all market users, including itself. 

This utility is exactly what the market needs.  All of the existing vendors focus on the higher value-added analytics.  The utility would focus on the necessary, but not very exciting task of collecting, verifying, standardizing and disseminating the loan-level performance data and terms of the deals.

... As we have remarked on many occasions, a more transparent and analysable market is certainly a welcome development, however with the issuer constituency in Europe dominated by banks who often enjoy alternative funding channels, the risk is clearly to the continuity of primary issuance as bank borrowers balance the increased costs, administrative burdens and competitive considerations of data transparency compliance against such alternatives.

It is the existence of alternative funding channels that ensures that, even though the ABS Data Warehouse has a monopoly, pricing for its service remains competitive.  If pricing gets too high, banks will move away from structured finance. 

In this respect, we would also remark that, unlike most other jurisdictions, the ECB has clearly singled-out securitisation for such enhanced transparency (as mentioned covered bonds and other instruments are largely exempt from similar requirements), which would of course mean that securitisation will ultimately provide far greater insight into bank asset profile and quality than anything provided on a statutory basis. 

Yet another important reason for the constructor of the ABS Data Warehouse to be free of all conflicts of interest.

Trustworthiness of Data in ABS Data Warehouse Requires No Conflicts of Interest

If the ABS Data Warehouse is going to restore confidence in structured finance securities, the single most important feature it must have is that the data is trusted.

Perceived to be Accurate


Improving disclosure standards requires providing accurate and unbiased current loan-level data to market participants on an observable event basis in such a manner that, like stock price data from the NYSE, trusting the data is not a question.

An “observable event” means, with respect to a loan or a receivable that is collateral for a securitization, any of the following:

1. payment (and the amount thereof) by the obligor on such loan or receivable; 
2. failure by the obligor to make payment in full on such loan or receivable on the due date for such payment; 
3. amendment or other modification with respect to such loan or receivable; 
4. the billing and collecting party becomes aware that such obligor has become subject to a bankruptcy or insolvency proceeding; or 
5. a repurchase request is asserted, fulfilled or denied.

The current reporting infrastructure has actual conflicts of interest, as participants such as Goldman Sachs and Morgan Stanley receive data on the loans backing structured finance securities on an observable event basis and trade on this information before other market participants receive this data.

In order to provide deal specific loan-level information to all market participants, a new data-handling infrastructure will be needed to collect, store and distribute the information to the market.

The ABS Data Warehouse would establish all of the various processes and systems necessary for the firms handling the daily billing and collecting to electronically submit the loan-level data. This data will be checked for accuracy and consistency and entered into a database. The data will then be made available to all market participants including investors, rating services, data providers, central banks and other regulators.

No Conflicts of Interest Allowed


The new infrastructure for collecting, storing and distributing loan-level data should be free of actual or perceived conflicts of interest. All market participants need to know that they can trust the data to credibly value, price and trade structured finance and covered bond securities. This is necessary if the new infrastructure is going to help restore confidence in the structured finance market.

The new data-handling infrastructure and the loan-level deal specific data should also be perceived as free of the types of structural conflicts of interest that would be present if the infrastructure was controlled by and the data offered by a single existing market participant.

Each existing market participant would be perceived as being able to gain a competitive advantage if it controlled the new data-handling infrastructure.  This is what is driving the European Commission's investigation of Markit with regards to credit default swaps information.

The involvement of existing market participants in the new data-handling infrastructure would tilt an otherwise level playing field without clear value added.

The ideal conflict free data-handling solution is an ABS Data Warehouse coordinated and operated by two independent third parties. This data warehouse would combine the global resources of the firm handling the data on a day-to-day basis with the subject matter expertise of the firm coordinating the data-handling infrastructure.

Full Disclosure Requirement


Any firm that is involved in either the day-to-day operation of the ABS Data Warehouse or the Coordinator role should be required to make a full disclosure of all competitive and financial interests in the design of the database, the presentation of the data, the analysis of the data, and the use of the data, including:

• Is the firm engaged in a related business that could gain a competitive advantage from its role? Examples of such related businesses include data distribution, pricing services, trustee services, monitoring, analytic solutions, loan servicing, collection services, consulting, ratings services, investment as a principal or agent or portfolio manager, and underwriting.

• Does the firm have investments that could benefit from its role, such as long or short positions in ABS transactions?

Accuracy of Data


The new data handling infrastructure should also provide an audit trail. Market participants should know that the data they are receiving from the ABS Data Warehouse is the same as the data submitted by the servicers or sub-servicers to the ABS Data Warehouse.

European Commission Alters ECB Search for Constructor of Groundbreaking ABS Data Warehouse

On April 1, 2011, the European Central Bank issued a letter to individuals interested in building and participating in the ABS Data Warehouse. [The interest in this Data Warehouse is not confined to the ECB, but parallels similar efforts by the Bank of England and the US Securities and Exchange Commission.]

The Eurosystem ... recognized the need to establish a data warehouse for the processing, verification and transmission of ABS loan-level data (the Data Warehouse).  The Eurosystem firmly believes that this initiative should facilitate investment and should support transparency, integrity and restore confidence in the structured finance markets as well as aid the simplification of data processes in the industry by ensuring investor access to comprehensive and standardised information across the European ABS market.  Loan-by-loan information will be made readily available to market participants utilising the Data Warehouse.

The Eurosystem expects that a Data Warehouse will be built by an independent constructor external to the Eurosystem.  To the extent possible, market participants will have the opportunity to use and invest in the Data Warehouse subject to entering into appropriate legal arrangements.

The Eurosystem fully supports an open, fair and transparent tender process for the selection of a Data Warehouse constructor.  The Eurosystem is acting as a catalyst in this initiative.  The Eurosystem is fully committed to ensuring an independent, fair, open and market-driven selection process in relation to the warehouse constructor and oversight of the Data Warehouse.

Not surprisingly, a self-appointed group of industry participants (the Market Group), has issued a press release discussing the beauty contest they are going to run to select a constructor of the Data Warehouse.

In December 2010 the Governing Council of the European Central Bank (the ECB) announced its intention to establish loan-by-loan data requirements for asset-backed securities (ABSs) in the Eurosystem collateral framework, with the aim of improving transparency and helping to restore investor confidence in the European securitisation markets.

Your humble blogger responded to the ECB's Public Consultation on which this announcement was based. See response.

To make this happen, the ECB is encouraging the creation of a groundbreaking ABS Data Warehouse for the processing, verification and transmission of loan-level data. Earlier this month, ECB President Jean- Claude Trichet invited market participants to lend their support to this innovative project. 

Once constructed, the ABS Data Warehouse will ensure that loan-level data is made available to market participants to increase transparency in relation to, and facilitate the risk assessment of, existing and future ABS transactions. Processes and software systems will be put in place that allow ABS originators to submit loan-level data to the ABS Data Warehouse electronically, and the loan-level data will be checked for compliance with the specific requirements for eligibility in the Eurosystem collateral framework as well as for consistency and timeliness.

At this point, I need to make a disclosure.  I have an economic interest in what happens with the ABS Data Warehouse.  In the 1990s, I designed and patented in the US this groundbreaking ABS Data Warehouse.  My patented information architecture combines processes and software systems in the most cost-efficient manner for electronically collecting, verifying and transmitting standardized loan-level data for each ABS security.  

Subsequent work on an ABS Data Warehouse has been based on the information I disclosed in the patent, in articles in trade publications, in speeches at industry conferences, in responses to public consultations or in confidential business plans.  

Structured finance is global.  According to the AFME, the outstanding balance of structured finance securities is approximately 10 trillion euros (8 trillion in the US and 2 trillion in Europe).  While structured finance securities are issued worldwide, each deal is designed to attract investors from around the world.  For example, think of all the investments made in US originated sub-prime securities by European financial institutions.  

Not only is the ECB trying to get the ABS Data Warehouse built, but there is also pressure from the European Union.  In May 2009, the European Parliament passed Article 122a to amend the European Capital Requirements Directive.  Under Article 122a, European financial institutions are required to know what they own when they purchase or hold a structured finance security.  A necessary pre-condition to knowing what you own for structured finance securities is to have access to the underlying loan-level performance data.  

Logically, this does not apply just to structured finance securities issued in Europe but also to structured finance securities that European financial institutions purchase that are issued in the US, UK or Asia.

Building a database for European residential mortgage backed securities is just the first step in building a global database for handling all structured finance securities.  As a result, the ABS Data Warehouse will need to be based on an information architecture that it has the legal rights to use in all parts of the world.

Back to the Market Group press release...

Specific ABS originators and investors from across Europe have formed an independent group of market participants called the “Market Group” to oversee the tender process and select a constructor of the ABS Data Warehouse.

At approximately the same time as the Market Group was issuing their press release, the European Commission was issuing its own related press release.  According to an article in the Telegraph, 

London-based Markit, the leading provider of CDS data, is ... being investigated [by the European commission].  The company,..., is already the subject of a separate inquiry by the US Department of Justice. 

Joaquin Almunia, European Commission vice-president responsible for competition, announced two investigations into the CDS market.... 

The first will look at whether dealers at 16 banks [most of whom are shareholders of Markit] colluded by giving "most of the pricing, indices and other essential daily data only to Markit." 

The commission believes this "may have [had] the effect of foreclosing the access to the valuable raw data by other information service providers' adding that some of the clauses in Markit's license and distribution agreements 'could be abusive and impede the development of competition."

According to a NY Times Dealbook article on the European Commission announcement,

The European officials are looking at whether banks, including Barclays and Goldman Sachs, have harmed rival organizations that could compete in markets for providing information and clearing a form of transaction that had become critical to the smooth functioning of the entire economy. 

“Lack of transparency in markets can lead to abusive behavior and facilitate violations of competition rules,” the European Union antitrust commissioner, Joaquin Almunia, said in a statement. “I hope our investigation will contribute to a better functioning of financial markets and, therefore, to more sustainable recovery.” 

... The banks are involved in two crucial components of the market for credit default swaps.

Sixteen of the banks are shareholders in Markit, a London-based organization that is the leading provider information on the market for credit default swaps. European Union officials suspect that the banks’ arrangements with Markit could effectively lock out other data providers. 

... Amelia Torres, a spokeswoman for Mr. Almunia, said that officials began the investigation without receiving formal complaints from competitors but said wrongdoing would be “obviously harming other players in the market.” 

ThomsonReuters, Standard & Poor’s and Bloomberg are among companies that could compete with Markit [to] provide information on trading credit default swaps.  

... The Justice Department has also been investigating this market and told The Times in December that its inquiry was focused on “the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries.” 

Clearly, having firms with a conflict of interest owning or controlling a leading provider of information does not pass the smell test.  


If the European Commission and the US Justice Department are concerned about Markit and its credit default swap database, they will be equally concerned with the ABS Data Warehouse and its dominant position in providing loan-by-loan data for structured finance securities.


The European Commission and the US Justice Department's concern effectively eliminates existing structured finance market participants from involvement in the ABS loan-level data warehouse.

Why?

Because each existing structured finance market participant has a conflict of interest.  They have another way of making money in the structured finance industry that could benefit from how the ABS Data Warehouse is operated.

Everyone involved in the Market Group is a current participant in the structured finance industry.  As a result, their ongoing involvement in selecting the constructor of the ABS Data Warehouse is tainted by their conflicts of interest and should cease.

The ECB is not going to be politically tone deaf to the European Commission's concerns.  There is no benefit nor is it a necessity for the ECB to allow a conflict of interest that would concern the European Commission or US Justice Department to exist involving the ABS Data Warehouse.  

The ECB wants to be involved in an ABS Data Warehouse that has absolute clarity on its lack of conflicts of interest with other structured finance market participants.  

As a result, what is needed is a search and not a beauty contest.

   

A search for a firm that meets two strict criteria.   

• The firm is verifiably free of conflicts of interest with other structured finance market participants.  This rules out existing market participants including issuers, investors, trustees, dealers, rating services, collection agencies, financial data vendors and accounting software providers.  

• The firm must have the demonstrated domain expertise to design, develop and manage all aspects of the ABS Data Warehouse.  

A search based on these criteria will find my firm and possibly others.